Signs have emerged in the past two weeks that China is paving the way for its currency to start appreciating. It may take a year or two to see even a 10% or 20% rise, and practically nobody else is writing about this at all (which surprises me), but this will mean big ramifications for investors.

Under steady pressure from the United States, Chinese policy planners have generally shrugged at the prospect of letting its currency appreciate. In recent months, other trading partners in Asia, along with emerging powerhouses such as Brazil have also chafed at a currency policy that has been seen to help China and hurt the rest of the world. Although the rising pressure has certainly been noted in Beijing, Chinese planners have long sought to let their currency appreciate when they're good and ready.

That time finally seems to be at hand.

Laying the groundwork
China's currency has actually begun to modestly appreciate in recent months. Six months ago, 10 yuan were worth about $1.46. That figure has steadily risen to a recent $1.52, though many economists think that if the yuan actually freely-floated on world currency markets, 10 yuan it would be closer to being worth $2.

Yet a number of steps need to be taken before the yuan is truly unfettered. For starters, businesses need to be able to ink deals in yuan outside of China's borders. That step was taken for Hong Kong a few months ago, and just this week, a group of China-based companies got the green light to enter into yuan-denominated contracts elsewhere in the world. It's only a small scale effort, but it's a start.

More intriguingly, the state-owned Bank of China has authorized foreign branches to start buying and selling yuan. That's a tricky move, because if foreigners start to speculate on an eventual steeper rise in the yuan, then many will seek to sell dollars and buy yuan. Right now, it's a bit hard to gauge the actual value of the yuan in a freely-floating currency world, but as noted above, the yuan is likely undervalued by at least 20%.

The lessons from other central banks that try to artificially depress the value of their currency need to be heeded. In places like Venezuela, locals and foreigners alike sell dollars in the black market, as they can do much better than the bank-sponsored rate. As China takes further steps to open up the yuan, pressure builds to make even more aggressive moves, lest a black market emerge.

Will all this play out in 2011? Probably not, but China's "beggar thy neighbor" currency policy does look set to end within the next few years. In the mean-time, the yuan may be allowed to appreciate further against the dollar, perhaps up to the $1.60 per 10 yuan rate.

Looking over the horizon
So if we are on a path that gets the yuan to strengthen -- perhaps by 20% to 25% from current levels -- you need to start thinking about your investment moves now. Here are just a few examples of the investment implications:

Action to Take --> You should pay attention to what's coming out of Beijing these days, because its currency moves will likely affect your portfolio in one way or another.

A rising Chinese consumer class should stimulate demand for certain U.S. imports, and highly-automated industries will become more competitive vis-a-vis their Chinese rivals. We may even see more Chinese companies acquire U.S.-based firms, which in itself may yield job creation. The areas above are just some of the ways your portfolio could be affected. But a correct reading of the tea leaves could protect you just as well as help you profit.

-- David Sterman

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